How to avoid blowups

Most new traders read the standard trading advice that states “risk control, not trade timing or signal generation, is the key to long-term success.” Yet most, myself included, completely ignore this advice.

“These are things I can pick up as I go along,” was the thinking. “First, I need to sort out my entry signals.”

My first account, like many first accounts, blew up; then my second and very nearly my third, before I started to think there might be something to this risk management thing so many successful traders talk about. Sure enough, I revisited my educational material, took risk management more seriously, and gradually my results started to improve.

I say “gradually” because it was not just a case of learning the concept. Knowing about risk and money management rules is not the same as implementing them consistently. Once I was able to do this, however, my third account recovered and remains the primary account that I trade today.

By sticking to two simple rules, I have built a career out of trading, and can say with certainty that I will not blow up another account as long as I follow these rules. Incorporate the same two rules into your own strategy, and you also can achieve the same level of confidence.

Staying alive

The first rule relates to money management. There are a thousand different definitions of the term, but simply put, money management is the act of ensuring that no matter the results of your trading operations, you will always have enough capital to place another trade. The rule is to never risk more than 2% of capital on any one trade. By sticking to this rule, logic dictates that available capital will never dry up.

Imagine you open your first account and fund it with $10,000. Two percent of your account is $200. You place your first trade risking this this $200, and you lose. You now have $9,800 in your account and must recalculate. Risking $200 no longer represents 2% of your account. The most you can risk on any trade now is $196. You do so, and again you lose. You now have $9,604 in your account, and can only risk $192 on your next trade.